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In January of 1637, prices of bulbs increased by more than 1000%. The price of one special, rare type of tulip bulb called Semper Augustus was 1000 guilders in 1623, 1200 guilders in 1624, 2000 guilders in 1625, and 5500 guilders in 1637 (equal to about $50,000).

One of the most remarkable results from research on experimental asset markets is the discovery of Smith, Suchanek, and Williams (1988)

Smith, Suchanek, and Williams (1988) ran 28 sessions of 15 rounds using a DOA design with a risky asset. They find that prices typically start well below expected value, bubble up in the middle rounds, and then collapse at the end of the experiment. This has been replicated many times, although there have been exceptions (Camerer and Weigelt, 1990).

Changes in institutions that might be expected to eliminate bubbles do not appear to have the expected effect.

King, Smith, Williams, and Van Boening (1993) allow for short selling, buying on margin, brokerage fees, and limits on price changes (circuit breakers). None of these institutional changes has much impact on the formation of bubbles.

Experiments were conducted using a standard continuous double oral auction program. A total of 16 sessions were run. Each session had between 12 and 18 periods, with the number of periods pre-determined and known by the subjects.

There were four main treatments:

One-Market: These were control sessions analogous to a standard bubble experiment. (4 sessions)

No-Spec: This treatment was designed to eliminate speculation as a possible cause for bubbles. Subjects were assigned a role as a buyer or a seller and were not allowed to resell units, eliminating any possibility of capital gains. (3 sessions)

Two-Market: A second market was added to the design. This market was for a non-durable good (service) that only lasted for one period. Subjects were assigned a role as a buyer or a seller in this market; supply and demand curves were induced in the standard fashion. This second market gives subjects something to do other than participate in the risky asset market. (6 sessions)

Two-Market/No Spec: This was the natural combination of the preceding two treatments – subjects in the risky asset market could no longer resell assets. (3 sessions)

1. The change in price from the current period to the next can be predicted by excess demand

2. Transaction volumes are greater during the boom phase

RESULT 2: Relationships between prices, quantities traded, and the number of offers to buy and sell, that were observed in earlier experimental studies of asset markets, do not require the presence of speculation(Table III).

However, bubbles are still observed and median prices are not significantly affected by the introduction of a second market.

Thus, the data supports the Active Participation Hypotheses, but this hypothesis cannot explain the pricing patterns in bubbles.

Results for TwoMkt Sessions

Results for two-market treatment. The volume of trades falls by about 35% when a second market is TwoMkt/NoSpec Sessions

Results for two-market treatment. The volume of trades falls by about 35% when a second market is TwoMkt/NoSpec Sessions

RESULT 5: The existence of a second market reduces the incidence of dominated transactions in markets in which speculation is not possible. There is no evidence of excess trade in TwoMarket/NoSpec.

Results for two-market treatment. The volume of trades falls by about 35% when a second market is TwoMkt/NoSpec Sessions

The authors conjecture that adding the second market reduces the chance that a bubble occurs, but they cannot confirm this without more data.

Results for two-market treatment. The volume of trades falls by about 35% when a second market is TwoMkt/NoSpec Sessions

RESULT 6: In TwoMarket and TwoMarket/NoSpec, departures of prices from fundamental values are a specific characteristic of the asset markets that does not extend to the service markets.

Conclusions two-market treatment. The volume of trades falls by about 35% when a second market is

The experimental results indicate that speculation is not necessary to create bubbles. Models of “rational” bubbles which rely on a failure of common knowledge of rationality receive little support here – at least some subjects are clearly making errors that are inconsistent with rationality.

The standard methodology drives some of the apparently irrational behavior. However, bubbles are not eliminated by using a methodology that gives subjects an option other than trading in the asset market.

Presenter’s Comments two-market treatment. The volume of trades falls by about 35% when a second market is

From the illustration of the experiment design, it seems that the subjects are not informed explicitly what the fundamental value is at a certain period.

The subjects may not know what the fundamental value is. Because there is cost of calculating the value, they may not bother doing it. Hence they are not certain about the fundamental value

Herd behavior happens when traders are not sure about the fundamental value

Experienced professionals (without speculative nature) may help eliminate the bubble

Additional Studies two-market treatment. The volume of trades falls by about 35% when a second market is

Dufwenberg, Lindqvist, and Moore (2003) study markets in which experienced and inexperienced traders are mixed. They find that even a fairly small proportion of experienced traders (1/3 of the population) is sufficient to largely extinguish the occurrence of bubbles.